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When do Countries form Regional Agreements? Social WelfareNo serious concerns, governments sign trade creating agreements Political InterestsGovernments may sign agreements that cater to specific interests. May be trade diverting and may alter future path of liberalization.

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Natural Partners Trade agreements are formed by countries that are near and trade a lot. –Krugman (1991) shows that when trade costs are low, regionalism is trade creating. –Frankel (1995) regional trade is more than explained by natural factors. –Krishna (2003) estimates welfare effects of 24 hypothetical agreements, neither volume nor geography are good indicators of gains from trade. –however 80 percent of agreements are welfare improving.

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Natural Partners cont. Baier and Bergstrand (2004) GE model to determine the country pairs that gain the most from an agreement. –Variables include distance, remoteness, income, similarity of income, comparative advantage. –Variables correctly predict 85% of actual agreements.

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Outcome If agreements are formed for political reasons, should observe significant trade diversion.

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Why the Difference? Limao examines EU and US where tariffs are already low. Diversionary costs less important. Preferences are North-South and may be for nontrade reasons. 90 percent of products have preferences.

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Regionalism and Multilateralism Mansfield and Reinhardt (2003) more RTAs formed during multilateral negotiations than at other times. US used NAFTA to push Uruguay Round Bergsten and Schott (1997)

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Deeper Integration Migration and Services offer larger gains Alesina and Spolaore (2003) economic benefits versus heterogeneity. –Sizepublic goods, home market effects, redistribution of income –Costsnational policies less satisfactory to more people. –These issues are clearly highlighted in EU Schengen, Turkey, Euro Lisbon Treaty. "We can still have elections, but we cannot use our vote to change legislation in the many areas where the Union is given power to decide. Danish MEP.

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Deeper Integration from Fragmentation of Production Is there a connection between fragmentation of production and regionalism? –Baldwin (2010) points out how it can enhance forces for liberalization. –Yi (2003) highlights effects of tariff liberalization on vertical specialization. –Together there can be a virtuous circle.

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Ongoing Work: Regionalism study ECA Did the EU expand vertical specialization? Dos this enhance growth? Does this lead to more synchronized GDP movements?

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What Should the WTO Do? Impose restrictions on PTA formation to confirm commitment to free trade. –Bind tariff rates at applied rates, leaving no room for tariff increases following a trade agreement. –Agree to lower multilateral tariffs part of the way with preferential tariffs. –Minimize of Rules of Originforcing tariff compression among regions. Allow only one ROO per agreement, not sector-specific ROO. Redefine North-South Agreements –Preferences from North in response to MFN liberalization from South.

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Conclusions Preferential trade agreements are distortionary –Governments choose well when forming agreements –Adjust trade policies to minimize costs Regionalism may endanger multilateralism –Really, we dont know, no counterfactual –Future studies can probe this question –A different discrimination may be the problem Products as opposed to country of origin

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What Should Countries Do? In 1991 Summers proclaimed that countries should pursue the living ism. Flaw is governments are entering into too many agreements, facilitating discrimination and increasing bureaucracy. Best strategy is unilateral, multilateral then and only then regional liberalization.

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Developing Country Concerns Tariffs tend to be much higher in the South. Exhaustion of scarce trade negotiating resources. Dependence on tariffs for tax revenue

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An Aside on the Models Endogeneity of tariffs--Common that everything besides FTA is exogenous. –Are gains from FTA so big that ML becomes undesirable? –Do outsiders benefit or lose when an FTA is formed. Aghion Antras and Helpman (2007) show as long as free trade maximizes governments joint payoff it will be reached. Ornelas (2008) show RTAs help get closer to free trade. Customs unions versus free trade areas.